Lloyd’s, Aon, the Berkshire ‘side car’ and the history of the London Market; what really is the strategic concern?

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The late ‘80’s was a very particular time and place in the City of London. ‘Big Bang’ and the Lawson boom set the tone for the UK’s financial centre’s own version of American Yuppiedom. Mobile phones the size of bricks, red braces, big hair, cocktails of dubious provenance, ‘Swing Out Sister’ (that’s a band!) and in the London insurance market the LMX spiral; in all its self-regarding and self-indulgent pomp.

The brief period of the highs then lows of the LMX market sometimes detracts from the recollection of a wider truth; that London had long been a ‘subscription’ market before ‘excess of loss’ reinsurance came to the fore. Indeed co-insurance meaningfully existed in London well before reinsurance really did anywhere. One could argue that London exists as an insurance centre in no small part because of its history as a subscription market with its ‘lead and follow’ underwriting culture.

At the time of LMX’s late ‘80’s hay-day your correspondent was a 20-something analyst at a small insurance data and ratings business called ISI (then owned by the stockbrokers FPK). It’s impossible not to recall that much of what I was analysing did seem to be a bizarre blend of ‘churn’ and hubris. No doubt that was, at least in part, the arrogance of (my) youth but, as we got into the ‘90’s and things started to unravel, my prejudices were, if anything, reinforced.

I therefore always enjoyed meeting intelligent and informed cynics of that world. One was an American working in London at Bankers Trust. I recall he saw the opportunities for how capital could be successfully deployed through London’s ability to attract risk and profitably distribute it via the syndication of capital, but was just perplexed by the way the market actually worked.

His name was Tom Bolt.

At that point Tom was looking to develop BT’s insurance derivatives business but if we recall that the young (or youngish) talent in the ‘traditional’ market at that time included (to name just a few) Stephen Catlin, John Charman, Tony Taylor, and Chris O’Kane (founding CEO’s of four of today’s top 40 global reinsurers) the reality of the market’s intellectual bedrock is clear.

The problems were partly the frictional cost of the then LMX spiral in general and the tiny percentages on line slips in the following market (all seemingly requiring a lot of ‘lunching’ by brokers), and the equally miniscule capital bases of many of them. But especially the lack of discrimination in risk pricing that came along with the following market. ‘What if the “lead” was wrong?’ was not a high priority question for a lot of that ‘innocent’ capacity?

Fast forward to 2013. Tom is, of course, Performance Director of the Lloyd’s Franchise Board (LFB); a body whose basic raison d’etre derives from the lessons learned in requiring that the ‘lead’ does indeed need to know what he or she is doing. The competitive advantage of London’s insurance market remains its unique collective intellectual property, innovation and global connectivity (we might call it a ‘cluster’) and the ability to syndicate capital.

So, Messrs Buffet and Jain decide they would now like to be part of London’s 2013 ‘following’ market. In stark contrast to the history above they offer very large scale capacity and the highest levels of security available. They are anything other than innocent capacity. Any incremental frictional cost appears tiny (at least as far as we can see) and the ‘lead’ is controlled by the discipline of the LFB.

That is simply a massive endorsement of what Lloyd’s has become. This seems a strategic threat only if you believe that London’s strengths actually don’t matter. And, if you do believe that, the game’s up anyway. Capital is a very fluid commodity; it has no need to be ‘located’ in London. So, if a large and very highly informed slug of it chooses to endorse underwriting decisions made at Lloyd’s, then that’s great, surely?

Naturally there is the concern that some market participants get ‘written down’ to accommodate the Berkshire behemoth, but ultimately Lloyd’s wants underwriting led market participants offering a globally diverse risk exposure in speciality lines, and especially more exposure to the world’s growth economies. If some market capacity in the existing business gets freed up by Berkshire’s supporting balance sheet then, fundamentally, that helps Lloyd’s and its underwriting leaders and innovators drive the market forward doesn’t it?

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It seems to me that this is an arrangement between 3 parties involving something that none of them owns – the right to choose where the contract is placed. Surely that decision rests with the buyer alone? If the buyer decides that Berkshire can have the 7.5%, or that it should be placed in Lloyd’s, or elsewhere, or that it’s up to Aon, it’s their decision.

Yes Lloyd’s offers well managed capital, underwriting skills and a tried and tested system, and the brokers do a tremendous job in sourcing the business from around the world, adding their own technical skills and an incredible production network, but it’s still up to the buyer where the business goes.

My own belief is that there are occasions when Lloyd’s doesn’t give enough credit to the brokers for their efforts (but as an ex-broker, maybe I would say that), and there is a danger that the increasing power of the big 3 looks worrying to Lloyd’s.

There also seems to be downward pressure on rates – whether this has been a catalyst is a matter for conjecture, but it’s convenient to have something to blame. Personally I believe that the differential between hard and soft markets is much smaller than it was in my day – if we’re moving towards the kind of soft market we saw in the 80’s I’d be very surprised. I also believe that shifting towards softer or harder markets is more down to human nature and sentiment – an excuse helps drive that sentiment.

I would add to that the possibility that the market is shifting to a more commoditised product could be a further fear for the market – the more standardised modelling and pricing become, the more homogenised the systems and rules that are put in place, the more possible it is to commoditise the product then perhaps the less value Lloyd’s can add. With the speculation that Willis may now be getting in on the act, this seems even more likely to be the case.

The bigger question then becomes – what does a commoditised market mean? More automation means fewer underwriters and brokers, perhaps more possibilities for ‘trading’ between renewals and maybe even new secondary markets…worrying and maybe exciting at the same time.